Duopolistic competition between independent and collaborative business-to-business marketplaces

This paper studies imperfect price competition between two intermediaries in an electronic business-to-business matching market with indirect network externalities. The intermediaries have different ownership structures: an independent incumbent competes with a collaborative buy side consortium to attract buying and selling firms. When firms can register exclusively with one intermediary, the incumbent can deter entry only if the number of consortium owners is sufficiently small. Otherwise, the consortium can enter and monopolize the market. When firms can register with both intermediaries simultaneously, the consortium can always enter and both intermediaries stay in the market with positive profits.     

Local network externalities and market segmentation

This paper models interaction between groups of agents by means of a graph where each node represents a group of agents and an arc represents bilateral interaction. It departs from the standard Katz–Shapiro framework by assuming that network benefits are restricted only amongst groups of linked agents. It shows that even if rival firms engage in Bertrand competition, this form of network externalities permits strong market segmentation in which firms divide up the market and earn positive profits. The analysis also shows that some graphs or network structures do not permit such segmentation, while for others, there are easy to interpret conditions under which market segmentation obtains in equilibrium.     

Search Costs and Investment in Quality

In this paper we analyze how lower search costs affect firms' incentives to invest in quality. We identify two conflicting effects. On the one hand, lower search costs increase incentives to invest in quality by eroding the market share of low quality firms and increasing the market share of high quality firms. On the other hand, by intensifying price competition, lower search costs adversely affect high quality firms more than low quality firms. The net effect of a change in the search cost on quality is shown to depend on the initial quality distribution. There is a critical value such that, if the proportion of high quality firms is initially below this value, lower search costs increase this proportion, whereas if the initial quality is above this value, lower search cost decreases the proportion of high quality firms. We show that our results are consistent with a ‘superstar effect.’     

Behavior based price personalization under vertical product differentiation

We study price personalization in a two period duopoly with vertically differentiated products. In the second period, a firm not only knows the purchase history of all customers, as in standard Behavior Based Price Discrimination models, but it also collects detailed information on its old customers, using it to engage in price personalization. The analysis reveals that there exists a natural market for each firm, defined as the set of customers that cannot be poached by the rival in the second period. The equilibrium is unique, except when firms are ex-ante almost identical. In equilibrium, only the firm with the largest natural market poaches customers from the rival. This firm has highest profits but not necessarily the largest market share. Aggregate profits are lower than under uniform pricing. All consumers gain, total welfare is higher herein than under uniform pricing if firms’ natural markets are sufficiently asymmetric. The low quality firm chooses the minimal quality level and a quality differential arises, though the exact choice for the high quality depends upon the cost specification.     

Non-linear pricing and conscious consumption

We consider a duopolistic market in which a green firm competes with a brown rival and each firm sells two quality-differentiated products. We study optimal non-linear contracts offered by the two firms when consumers: (i) Are privately informed about their willingness to pay for quality, and (ii) differ in their environmental consciousness. We characterize how consumers with different valuations for quality self-select into firms and show that the ranking of qualities, relative prices and profits all depend on the interplay between consumers’ valuations and firms’ cost heterogeneity. Interestingly, when consumers’ valuations for quality are relatively low, the brown firm does not offer a low-quality variety. This contrasts with the situation of full information, in which both firms commercialize a high- and a low-quality variety. Hence, the lack of information about consumers’ valuations may not only favor the green firm in terms of higher prices and profits, but also reduce the product range offered by the brown rival.     

Segmentation, advertising and prices

This paper explores the implications of market segmentation on firm competitiveness. In contrast to earlier work, here market segmentation is minimal in the sense that it is based on consumer attributes that are completely unrelated to tastes. We show that when the market is comprised by two consumer segments and when there is sufficient variation in the per-consumer costs firms need to incur to access the different consumer populations, then firms obtain positive profits in symmetric equilibrium. Otherwise, the equilibrium is characterized by zero profits. As a result, a minimal form of market segmentation combined with advertising cost asymmetries across consumer segments give firms an opportunity to generate positive rents in an otherwise Bertrand-like environment.     

Taking industry structuring seriously: A strategic perspective on product differentiation

Given legal impediments to consolidation and collusion, firms often resort to product differentiation to attain market power. This paper provides a formal analysis of product differentiation as a tool for such industry structuring at both the firm and industry level. We examine: how industry structure differs when firms collaborate on their differentiation decisions, and when the profitability of such collaboration is greatest; how an individual firm's differentiation decisions affect subsequent market outcomes under price competition, such as margin, market share, and profit; how mere differentiation differs from a ‘differentiation advantage’; and how changing a firm's differentiation affects its rivals through both positive externalities (by restraining rivalry) and negative externalities (by shifting competitive advantage). Our results have implications for empirical research, strategy theory, and pedagogy.     

Supporting New Product Launches With Social Media Communication and Online Advertising: Sales Volume and Profit Implications

The question of how important firms’ investments in digital communication formats are for the commercial success of new products remains unexplored in the product innovation management literature. Drawing on reactance theory, the authors examine the extent to which investments in social media communication and online advertising are related to the sales volume and profits of new products within six months of being launched. Using dyadic survey data, an analysis of new products launched by 122 consumer durable goods firms reveals that sales volume and profits of new products are associated with (1) social media communication in a positive but diminishing shape, and (2) online advertising in an inverted U‐shape. Further analyses show that those curvilinear relationships are steeper for social media communication and flatter for online advertising at respective (1) higher levels of customer product involvement and (2) lower levels of product superiority. The results imply that there is an optimal level of investment in social media communication and online advertising, with the optimum dependent on a new product’s consumer involvement and superiority levels.     

Is a Big Entrant a Threat to Incumbents? The Role of Demand Substitutability in Competition Among the Big and the Small

We establish a model of market competition between large and small firms and investigate the way in which demand substitutability affects how the entry of big firms impacts incumbents. We focus on the relative strength of two opposing effects of entry on large incumbent firms’ demand: the direct substitution effect among large firms (negative) and the indirect feedback effect through the change in small firms’ aggregated behavior (positive). If the substitutability between large and small firms is sufficiently high, the indirect effect dominates the direct effect and large incumbents’ equilibrium prices and profits increase. We show that welfare effects are ambiguous, which calls for careful assessment when regulating large firms’ entry.     

The impact of competitive advantage on the investment timing in Stackelberg leader–follower game

This short note clarifies how the Stackelberg leader’s competitive advantage after the follower’s entry affects the leader’s optimal market entry decision and Stackelberg strategic interactions under uncertainty. Although the Stackelberg leader’s first investment threshold remains constant and coincides with the monopolist’s investment trigger, his second (third) investment threshold, which defines the exit (entry) of the first (second) investment interval, increases with an increased competitive advantage. With an increased competitive advantage, the probability of sequential investment equilibrium (simultaneous investment equilibrium) increases (decreases) irrespective of the level of volatility. Moreover, for a given level of competitive advantage, an increase in the volatility tends to decrease (increase) the probability of simultaneous investment equilibrium (sequential investment equilibrium). For a richer set of results, endogenous firm roles are examined and analyzed as well. The leader’s preemptive threshold is negatively affected by his competitive advantage.     

All-pay competition with captive consumers

We study a game in which two firms compete in quality to serve a market consisting of consumers with different initial consideration sets. If both firms invest below a certain threshold, they only compete for those consumers already aware of their existence. Above this threshold, a firm is visible to all and the highest investment attracts all consumers. On the one hand, the existence of initially captive consumers introduces an anti-competitive element: holding fixed the behavior of its rival, a firm with a larger captive segment enjoys a higher payoff from not investing at all. On the other hand, the fact that a firm’s initially captive consumers can still be attracted by very high quality introduces a pro-competitive element: a high investment becomes more profitable for the underdog when the captive segment of the dominant firm increases. The share of initially captive consumers therefore has a non-monotonic effect on the investment levels of both firms and on consumer surplus. We relate our findings to competition cases in digital markets.     

The Estimation of a Cusp Model to Describe the Adoption of Word for Windows*

This article revisits earlier work in this journal by Paul Herbig (1991) that proposed a catastrophe model of industrial product adoption under certain conditions. Catastrophe models are useful for modeling situations where organizations can exhibit both smooth and abrupt adoption behavior. It extends Herbig's work by focusing on organizations' adoption of new products when network externalities are an important part of the decision process, and it presents an empirical estimation of the model. Network externalities occur when firms do not want to adopt a new innovation or product unless other firms do. The reason is that they do not want to end up with an innovation that ends up not being a standard of some sort. Mistakes of this nature can be costly as the firm must invest twice and loses time relative to competitors who have not made such a mistake. However, when such externalities exist, for example with regard to technological adoptions, then normal diffusion gives way to sudden discontinuous shifts as all firms seemingly act together an move to a new technology. Since, technology is an area where the authors expect network externalities to exist, that is the focus of this article. The specific application is developed from two sets of panel data on the organizational adoptions of Microsoft's (MS) Word for Windows software by organizations that previously were using either Word for DOS or Word for Macintosh (Mac). The theoretical framework for the analysis is based on work in the economics literature on network externalities. However, the organization and new product development catastrophe model comes primarily from Herbig (1991) . The article focuses on an area of organizational adoption where relatively little empirical research has been done, namely organizational adoption “for use.” Longitudinal data provided by Techtel Corporation is used to develop the estimations. Results of the empirical analysis are consistent with the theoretical framework suggested in Herbig's article and in those found in economics and catastrophe theory literatures. This lends clear support to the idea that organizations will adopt a bandwagon‐type behavior when network externalities are present. It further suggests that in such markets, the standard S‐shaped diffusion curve is not an appropriate model for examining organizational behavior. From a managerial perspective, it means that buyers and sellers may face nonstandard diffusion curves. Instead of S‐shaped curves, the actual curves have a break or rift where sales end, and there is a sudden shift to a new product that is relatively high very early on. Clearly, for new product development (NPD), it suggest that organizations' “for‐use” purchases may be similar to regular consumers and may change rapidly from one product to another almost instantly, as in the case of the switch from vinyl records to compact discs (CDs). From an old product seller's viewpoint, the market is here today and gone tomorrow, while for the new seller it is a sudden deluge of sales requests. To put it in more everyday terms, sudden changes in adoption behavior are a September 11‐type experience for the market. It is the day the world changes.     

Personalized pricing and advertising: Who are the winners?

This paper investigates who wins and who loses when firms depart from a mass advertising/uniform pricing strategy (benchmark model) to a targeted advertising/price discrimination one. Considering a duopoly market in which firms simultaneously compete in prices and advertising decisions, we examine the competitive and welfare effects of personalized pricing with targeted advertising by comparing equilibrium outcomes under customized advertising/ pricing decisions to the results arising under mass advertising and uniform pricing. We show that, when both firms compete in both market segments, all segment consumers are expected to pay higher average prices under the personalized advertising/pricing strategy. We also show that, in the context of our simultaneous game, targeted advertising with price discrimination might boost firms’ profits in comparison to the case of mass advertising and uniform prices. The overall welfare effects of the personalized strategy are ambiguous. However, even when the personalized strategy boosts overall welfare, consumers might all be worse-off. Thus the paper gives support to concerns that have been raised regarding the firms’ ability to adopt personalized strategies to boost profits at the expense of consumers.     

The Impact of Market Structure and Learning on the Tradeoff between R&D Competition and Cooperation

This paper compares R&D competition and cooperation when firms can devote resources to a ‘safe’ investment or a risky R&D investment. When the discovery of a new product creates positive externalities on non‐discovering firms, equilibrium investment flow, ex ante investment, and welfare under R&D competition are less than or equal to what they are under research cooperation. With negative externalities, R&D cooperation results in the same or lower ex ante investment than under R&D competition, and social welfare may also be less. Our results have relevance for empirical studies of the impact of R&D cooperation on R&D outcomes.     

Pricing with customer recognition

This article studies the dynamic effects of behaviour-based price discrimination and customer recognition in a duopolistic market where the distribution of consumers' preferences is discrete. Consumers are myopic and firms are forward looking. In the static and first-period equilibrium firms choose prices with mixed strategies. When price discrimination is allowed, forward-looking firms have an incentive to avoid customer recognition, thus the probability that both will have positive first-period sales decreases as they become more patient. Furthermore, an asymmetric equilibrium sometimes exists, yielding a 100–0 division of the first-period sales. As a whole, price discrimination is bad for profits but good for consumer surplus and welfare.     

Is targeted advertising always beneficial?

In this paper, we study a simple model in which two horizontally differentiated firms compete in prices and targeted advertising on an initially uninformed market. First, the Nash equilibrium is fully characterized. We prove that when the advertising cost is low, firms target only their “natural markets”, while they cross-advertise when this cost is high. Second, the outcome at equilibrium is compared with random advertising. Surprisingly, we prove that firms' equilibrium profits may be lower with targeted advertising relative to random advertising, while firms are given more options with targeted advertising.     

CREDIBLE RETALIATORY ENTRY AND STRATEGIC TOE‐HOLDS*

The anticipated profits from entry by an established firm into a new market will depend on how incumbents in that market are expected to respond. One possibility, suggested by cases and the literature, is that an incumbent may respond with ‘retaliatory entry’ into the first entrant's ‘home’ market. The model presented here describes conditions under which this can be a credible threat that deters the first entry. When the conditions are such that it is not credible, the paper shows how firms can provide credibility through the establishment of toe‐hold investments in other markets.     

Downstream mergers in vertically related markets with capacity constraints

Motivated by a recent merger proposal in the French outdoor advertising market, we develop a model in which firms are initially endowed with some advertising capacities and compete on two fronts. First, firms compete to acquire additional advertising capacities on an upstream market; a first stage modeled as a second-price auction with externalities. Second, those firms, privately informed on their own costs, use their capacities on the downstream market to supply advertisers whose demand is random; a second stage modeled by means of mechanism design techniques. We study the linkages between the equilibrium outcomes on both markets. When a firm is endowed with more initial capacity, through the acquisition of a competitor for instance, whether it becomes more or less eager to acquire extra capacity on the upstream market depends a priori on fine details of the downstream market. Under reasonable choices of functional forms, we demonstrate that a downstream merger does not create any bias in the upstream market towards the already dominant firm.     

Risky quality choice

In vertical product differentiation with a stochastic research technology, firms should target their research at different quality levels for efficiency. In a natural monopoly where the top firm finds it most profitable to sell to the whole market, the incentives for risk-taking and for firms to differentiate their targeted qualities are optimal. In a natural oligopoly (which results when there is sufficient dispersion of tastes), the relationship between a firm’s payoff and its quality improvement over other firms is weakened. This diminishes the firms’ incentives to differentiate and the targeted qualities are too low and too close together.     

Losing by winning: The danger zone of adverse competitor replacement

Research Summary: We use a formal model, motivated by a case study from the airline industry, to consider an industry structure wherein a firm may find that improving its competitiveness hurts its performance. Specifically, we examine the possibility that a superior incumbent may, by getting stronger, drive a weak rival from the market, and thereby allow a stronger rival to enter in its place. Such “adverse competitor replacement” reduces the profit of the superior incumbent and may even, in an extreme case, cause the superior incumbent to be driven from the market as well. We show that adverse competitor replacement can arise under a rational equilibrium and may become more likely if a firm improves its capability for self‐improvement. Managerial Summary: Managers are consistently advised to improve the competitiveness of their firms and beat the competition. We examine the possibility that beating out the competition may have adverse consequences. Specifically, a strong incumbent may, by getting stronger, outcompete a weaker rival to such an extent that the weaker rival exits the market, thereby creating an open market niche for a stronger rival to enter, in effect, a form of adverse competitor replacement. Competing with this stronger rival may in turn reduce the strong incumbent's profits below what they had been before driving the weak rival out. We illustrate adverse competitor replacement with a case study from the airline industry and discuss implications for a firm's investment in its own competitiveness.